Actual statistics for component X
1.9 JUST IN TIME
1.9.2 Impact of JIT System
Clearly, the changes imposed by a JIT system are profound and can greatly improve company operations when installed and operated correctly. They can also have a profound effect on product costs.
company effectively eliminates activities that do not contribute to the value of a product, which in turn reduces the costs associated with them.
Another way in which waste is eliminated in a JIT system is to charge cost drivers to wasteful activities that accumulate costs. For example, overhead costs can be charged out based on the number of components in a product (since more parts require more purchasing activity and materials handling), the number of material moves (which is not a value-added activity), or the number of units scrapped. In this way the cost of these activities becomes apparent to management, and as a result, there will be considerable focus on reducing these cost drivers since the accounting system places so much emphasis on their total burdened costs. Then, when these cost drivers have been reduced to significatnt levels, the cost accountants can find other wasteful cost drivers and shift the allocation system to place the most emphasis on them. This directs management’s attention toward their elimination, too. And so on. In this way the cost accounting system can be continually altered so that it has a direct, active role in reducing wasteful activities.
1.9.2.1 impact of jit on overhead costs: the costs of material handling, facilities, and quality inspection decline when a jit system is installed. In addition, the reduction of all types of inventory results in a massive reduction in the amount of space required for the warehouse facility. Since all costs associated with the warehouse are assigned to the overhead cost pool, the amount of overhead is reduced when the costs of staff, equipment, fixed assets, facilities, and rent associated with the warehouse are sharply cut back.
There is also a shift of costs from the overhead cost pool to direct costs when machine cells are introduced. The reason for this change is that a machine cell generally produces only a small range of products, making it easy to assign the entire cost of each machine cell to these items. This means that the depreciation, maintenance, labour and utility costs of each cell can be charged straight to a product, which is preferable to the traditional approach of sending these costs to an overhead cost pool from which they are assigned to products in much less identified manner. Though this change does not represent a cost increase or reduction, it does increase the reliability of allocation for many more costs than that was previously the case.
Despite the shift of many overhead costs to direct costs, there is still an overhead cost pool left over that must be allocated to products. However, given the large number of changes implemented as part of the JIT system, cost accountants may find that there are now better allocation bases available than the traditional direct labour allocation. For example, the amount of time a product takes in each work cell may be a better measure for allocating costs, instead of amount of space occupied in the work cells that create each product. No matter what allocation system is used, it is some what different from the old system, so there is a shift in the allocation of costs between different products.
In short, overhead costs decline as some costs are eliminated, while other costs shift between products as more costs are charged directly to products and the remaining overhead costs are charged out using different allocation methods.
1.9.2.2 impact of jit on other costs: When a jit system in created, the amount of inventory retained in a company drops continuously. Raw materials inventory is reduced because
suppliers deliver only small quantities of parts as and when they are needed. Work-in-process inventory drops because the conversion to machine cells and the use of kanban cards greatly reduces the need to pile up inventory between machines. Finally, finished goods inventory drops because inventory is produced only when there are orders in hand from customers (though finished goods inventories are also allowed to build if a company experiences high seasonal sales). Consequently, the cost of maintaining inventory declines, which in turn reduces the overhead costs associated with inventories that are charged to products. Some of these inventory-related costs are:
• Interest cost related to the debt that funds the inventory investment
• Cost of inventory that becomes obsolete over time
• Cost of rent for inventory storage facilities
• Cost of all equipment used in the warehouse
• Cost of warehouse utilities
• Cost of warehouse employees
• Cost of insurance needed to cover the possible loss of inventory
• Cost of taxes on the inventory
According to several estimates the annual cost of inventory is 25% of the total inventory investment. By eliminating excessive storage of inventory a company experiences not only a decline in its inventory investment but also the elimination of all associated costs.
Besides a reduction in the level of working capital and inventory-related costs, a company can also reduce its investment in capital assets. This occurs when a company with a few large machines replaces them with a larger number of much smaller, more easily configured machines. Then, equipment setup times become shorter, which in turn makes it profitable to have shorter production runs, thereby eliminating an excessive investment in inventory that would have been created by excessively long production runs. There is frequently a saving when such a change occurs, which releases cash for other uses while also reducing the amount of depreciation charged to overhead.
A potentially significant one-time cost that many companies do not consider involves the cost layers in their inventory costing systems. When a JIT system is installed, there is an immediate focus on eliminating inventory of all types. If a company uses some kind of layering method to track the cost of its inventory, such as last-in-first-out or first-in-first-out, it will find itself burrowing down into costing layers that may have been undistributed for many years.
Then, some unusually high or low costs may be charged off to the cost of goods sold when these inventory items are finally used up. For example, if the current market cost of a piston is Rs. 5,000/- but a company has some old (but serviceable) ones in stock from 20 years ago that cost Rs. 2,000, then only the Rs. 2,000 unit cost is charged to the cost of goods sold when these units are finally used as a result of clearing out the inventory. Because of the unusally low cost of goods sold, the gross margin is higher than usual until these early cost layers are eliminated. Because of the lower-of-cost-or-market rule (under which the cost of
excessively expensive inventory must be reduced until it is not higher than the current market value), this problem tends to be less of an issue when early cost layers are too high, though the costs charged are still somewhat different from those for newer layers of inventory. Once all cost layers have been used up, the only costs the management sees being charged to the cost of goods sold are those currently charged by suppliers.
Thus, the cost reductions and reduced capital requirement of JIT systems have a significant impact on the levels of fixed assets, working capital, and inventory needed to run a business, which in turn reduces the associated overhead costs charged to products.
1.9.2.3 impact of JIT on product prices: when a company achieves a higher level of product quality, along with ability to deliver products on the dates required, customers may be willing to pay a premium. This is particularly true in industries where quality or delivery reliability is low. If customers are highly sensitive to these two factors, it may be possible to increase prices substantially. Alternatively, if these factors are not of great importance, or if customers place a higher degree of importance on other factors, then there will be no opportunity for a price increase.
In industries where many companies are adopting JIT systems at the same time or have already installed them, an improvement in product quality and delivery times does not differentiate a company from its peers. Instead, since everyone else is offering the same level of quality and service, it just keeps a company from losing sales to its competitors. In such a situation it is more likely that all companies remaining in the industry will use their new-found lower costs to initiate a price war that will result in a drop in prices.
Consequently, the impact of a JIT system on product pricing is primarily driven by customers’
perceived need for higher product quality and reliable delivery times, as well as the presence of competitors with JIT system, the same installation, and operational base.
1.9.2.4 JIT cost allocation differences: the chief difference between the types of cost allocations under jit and traditional environment is that of converting most of the overhead costs to direct costs. The primary reason for this change is the machine cell. Because a machine cell is designed to produce either a single product or a single component that goes into a similar product line. Therefore all the costs generated by the machine cell can be charged directly to the only product it produces. When a company completely change over to the use of machine cells in all locations, the costs related to all the cells can now be charged directly to products, which leaves few costs of any kind to be allocated through a more traditional overhead cost pool. the result of this change results in more accurate product costs.
Specifically, the costs that can now be charged directly to product are:
• Depreciation. The depreciation cost of each machine in a machine cell can be charged directly to a product. It may be possible to depreciate a machine based on its actual use, rather than charging off a specific amount per month, since this allocation variation shifts costs to a product more accurately.
• Electricity. The power used by the machine in a cell can be separately metered and then charged directly to the products that pass through the cell. Any excess electricity cost
charged to the facility as a whole still has to be charged to an overhead cost pool for allocation.
• Material handling. Most materials handling costs in a JIT system are eliminated since machine operators move parts around within their machine cells. Only costs for materials handling between cells should be charged to an overhead cost pool for allocation.
• Operating supplies. Supplies are used mostly within the machine cells, so the majority of items in this expense category can be separately tracked by individual cell and charged to products.
• Repairs and maintenance. Nearly all the maintenance costs a company incurs are for machinery and they are all grouped into machine cells. By having the maintenance staff, charge their time and materials to these cells, these costs can be charged straight to products. Only maintenance work on the facility is still charged to an overhead cost pool.
• Supervision. If supervision is by machine cell, the cost of the supervisor can be split among the cells supervised. However, the cost of general facility management as well as of any support staff, must still be charged to an overhead cost pool.
As noted in several of the preceding items, a few remainder costs are still charged to an overhead cost pool for allocation. However, these represent a small percentage of the costs, with nearly everything now being allocable to machine cells. Only building occupancy costs, insurance, and taxes are still charged in full to an over-head cost pool. This is a vast improvement over the amount of money the traditional system allocates to products. A typical overhead allocation pool under the traditional system can easily include 75% of all costs incurred, whereas this figure can be dropped to less than 25% of total costs by switching to a JIT system. With such a higher proportion of direct costs associated with each product, managers then have much more relevant information about the true cost of each product manufactured.